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Taxation of Digital Goods and Services \\jciprod01\productn\N\NYS\70-4\NYS402.txt unknown Seq: 1 24-NOV-15 14:55 TAXATION OF DIGITAL GOODS AND SERVICES CATHERINE CHEN* INTRODUCTION I. CONSTITUTION AND FEDERAL STATUTES: PREEMPTION AND LIMITATIONS ................. 425 R A. Constitutional Limitations on State Taxation of Streaming Content .............................. 426 R 1. Due Process Clause .......................... 426 R 2. Dormant Commerce Clause ................. 428 R i. Current Jurisprudence ................... 429 R ii. States’ reaction to Quill .................. 431 R B. Federal Statutes ................................. 435 R II. SHOULD DIGITAL CONTENT BE TAXED? A POLICY DISCUSSION ............................... 437 R A. Efficiency ........................................ 437 R 1. Leveling the Playing Field ................... 438 R 2. Addressing Diminishing State Revenue ...... 440 R B. Technical Difficulties with Imposing a Tax....... 440 R C. Protecting Small Businesses ...................... 444 R D. Tax Policy Goals ................................. 446 R III. HOW TO TAX INTERNET STREAMING............ 447 R A. A Survey of States’ Approaches .................. 448 R 1. Definition of “Digital Products” .............. 449 R 2. Tax Treatment .............................. 450 R 3. Sourcing of Digital Products ................. 455 R 4. Problems with a State-by-State Solution ...... 457 R B. A Federal Solution .............................. 458 R 1. Why a Federal Solution Is Necessary ......... 458 R 2. Marketplace Fairness Act .................... 460 R 3. Digital Goods and Services Tax Fairness Act . 465 R C. Suggestions ...................................... 466 R * J.D. 2015, New York University School of Law. I am deeply indebted to Professor David Kamin for his thoughtful advice and guidance. I would also like to thank the editorial staff of the NYU Annual Survey of American Law, especially Ryan Gerber, Paul Balik, Megan Graham, Junine So, Christina Liu, Kaitlyn Gosewehr, Matthew Wilkins, Jaclyn Hall, and Daryl Kleiman for their insightful commentary and meticulous edits. Finally, I would like to thank my mother, Xuewei and husband, Richard, for their ceaseless encouragement, love, and support throughout this project and all my endeavors. 421 \\jciprod01\productn\N\NYS\70-4\NYS402.txt unknown Seq: 2 24-NOV-15 14:55 422 NYU ANNUAL SURVEY OF AMERICAN LAW [Vol. 70:421 1. Suggested Changes to the Marketplace Fairness Act ................................. 467 R 2. Suggested Changes to the Digital Goods and Services Tax Fairness Act .................... 471 R CONCLUSION ............................................. 474 R APPENDIX ................................................. 477 R INTRODUCTION Have you ever listened to the latest hits from your favorite artist on Spotify or Beats Music? Or read an e-book on your Kindle? Or perhaps you are even contemplating streaming the newest season of House of Cards on Netflix or Game of Thrones on HBO instead of reading this Note. If you answer yes to any of the above, you are not alone. Digital content is becoming an increasingly ubiquitous part of our modern lives, and its consumption is growing exponentially,1 quickly surpassing that of its physical counterparts. In 2008, 10 mil- lion electronic books were sold in the United States.2 Four short years later that number rose to 457 million,3 and Amazon an- nounced that its Kindle e-book sales surpassed print sales in both the United States and the United Kingdom.4 In 2014, the music industry saw a 13.3.% decrease in physical music album sales, from 89.5 million in 2013 to 77.6 million in 2014; over the same period, the number of digitally streamed songs increased by 54% from 106 billion in 2013 to 164 billion in 2014.5 Market watchers report that video streaming services are also growing quickly and are poised to replace traditional cable television.6 Fifty-four percent of total 1. According to the Association of American Publishers and the Book Indus- try Study Group, e-book and digital music sales rose 44% and 9.1% respectively in 2012. See Melanie Hicken, Are You Paying the iTunes Tax?, CNN MONEY (June 5, 2013, 12:24 PM), http://money.cnn.com/2013/06/05/pf/taxes/itunes-tax/?iid =EL#TOP. 2. E-book Sales are up 43%, but That’s Still a ‘Slowdown’, USA TODAY (May 16, 2013, 11:16 AM), http://www.usatoday.com/story/life/books/2013/05/15/e- book-sales/2159117/?AID=10709313&PID=6154686&SID=14rqn2wl5pki9. 3. Id. 4. Jason Kincaid, That Was Fast: Amazon’s Kindle Ebook Sales Surpass Print (It Only Took Four Years), TECHCRUNCH (May 19, 2011), http://techcrunch.com/ 2011/05/19/that-was-fast-amazons-kindle-ebook-sales-surpass-print-it-only-took- four-years/; Adario Strange, Amazon U.K. E-Book Sales Surpass Print, PCMAGAZINE (Aug. 7, 2012, 8:37 AM), http://www.pcmag.com/article2/0,2817,2408135,00.asp. 5. NIELSEN, 2014 NIELSEN MUSIC U.S. REPORT 1–2 (2015), available at http:// www.nielsen.com/content/dam/corporate/us/en/public%20factsheets/Sound- scan/nielsen-2014-year-end-music-report-us.pdf. 6. Digital TV, Movie Streaming Reaches a Tipping Point, EMARKETER (Apr. 2, 2013), http://www.emarketer.com/Article/Digital-TV-Movie-Streaming-Reaches- \\jciprod01\productn\N\NYS\70-4\NYS402.txt unknown Seq: 3 24-NOV-15 14:55 2015] TAXATION OF DIGITAL GOODS AND SERVICES 423 bandwidth usage in peak evening hours are from streaming videos7—an amazing feat considering the versatility of the Internet. As you are enjoying your digital content, did you consider what exactly you are paying for? Is it a good or service? Or are you creas- ing your brows at these inane questions and wondering why it should matter? The differentiation is important for state and local taxing authorities because goods and services are often taxed very differently. And if you are uncertain about whether digital content is a good or service, then you are in good company. When the Or- ganisation for Economic Co-operation and Development (OECD) studied the tax challenges posed by our now digital economy, it recognized the prevalence of retailers selling digital goods and ser- vices.8 The report found the line between goods and services in- creasingly blurry, as digital content continues to evolve and to grow more ubiquitous.9 In addition, the tax challenge becomes more complex as the industry expands from traditional retailers to inno- vative service providers such as educational institutions.10 As more consumers switch to digital music, books, and movies, states increasingly lose tax revenue from decreasing physical sales. Tipping-Point/1009775; Paul Snyder, The Future of Cinephilia: Will Streaming Movies Replace DVD, HUFFINGTON POST (May 25, 2011, 4:40 PM), http://www.huffing tonpost.com/paul-snyder/the-future-of-cinephilia_b_601437.html. 7. Lily Hay Newman, 35 Percent of Total Bandwidth Usage in the Evenings Is from Everyone Watching Netflix, SLATE (Nov. 21, 2014, 4:01 PM), http://www.slate.com/ blogs/future_tense/2014/11/21/new_sandvine_report_shows_that_35_percent_ of_evening_bandwidth_usage_is.html (“A report . shows that ‘34.9 percent of downstream traffic in peak evening hours’ in North America is from Netflix use. In contrast, only 14 percent is from YouTube, 2.58 percent is from Amazon Instant, 1.41 percent is from Hulu, and 1 percent is from HBO Go.”). 8. ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT, ADDRESS- ING THE TAX CHALLENGES OF THE DIGITAL ECONOMY 74–75 (2014) [hereinafter OECD REPORT], available at http://www.oecd-ilibrary.org/taxation/addressing- the-tax-challenges-of-the-digital-economy_9789264218789-en. Some examples of digital content include downloadable and streaming music and movies, executable code, games, and services based on data processing. Id. 9. Id. at 58. 10. The OECD report noted that universities, tutor services and other educa- tion service providers now are able to provide courses remotely through streaming and video conferencing, which “enables them to tap into global demand and lever- age brands in a way not previously possible.” Id. at 72. Examples of those services include online bar preparation courses offered by companies such as BARBRI, KAPLAN, and Themis as well as online juris doctor programs offered by some law schools. Even traditional law schools such as New York University are offering on- line courses for LLM students in selected programs to facilitate their studies while working part- or full-time. See N. Y. Univ. Sch. of Law, Executive LLM in Tax, http:/ /www.law.nyu.edu/llmjsd/executivellmtax (last visited May 5, 2015). \\jciprod01\productn\N\NYS\70-4\NYS402.txt unknown Seq: 4 24-NOV-15 14:55 424 NYU ANNUAL SURVEY OF AMERICAN LAW [Vol. 70:421 This increases pressure to tax digital content.11 However, govern- ments worldwide12 find that taxing digital products is especially challenging because digital products are often “a mix of an intangi- ble product and a service” and therefore do not fit neatly into most existing tax laws.13 To make matters worse, many states have devel- oped widely variant and incoherent taxing approaches, making for a patchwork national system.14 This became especially evident in the recent “Netflix cases” that have emerged in various states.15 This Note will study the taxation of digital goods and services. The following discussion is divided into four parts. Part I lays out the backdrop for the discussion by examining the restraints cur- rently placed on state and local government taxation by the Consti- tution and federal laws. It addresses the extent to which digital goods and services can be taxed. Part II focuses on policy goals such taxation may serve and discusses whether taxation should be im- posed. Part III studies how digital content should be taxed. It surveys the various states’ approaches and analyzes the two most prominent proposed federal solutions—the Marketplace Fairness Act (MFA)16 and Digital Goods and Services Tax Fairness Act (DGSTFA)17—to determine the extent to which they satisfy the constitutional restrictions identified in Part I and the policy goals identified in Part II. Finally, Part III makes a recommendation for taxing digital content.
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